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ESSAYS ON BUSINESS CYCLE VOLATILITY AND GLOBAL TRADE by Arian Farshbaf Yazdandoust
A Dissertation Presented to the FACULTY OF THE USC GRADUATE SCHOOL UNIVERSITY OF SOUTHERN CALIFORNIA In Partial Fulfillment of the Requirements for the Degree DOCTOR OF PHILOSOPHY (ECONOMICS)
August 2012
Copyright 2012 Arian Farshbaf Yazdandoust

The main thesis of this dissertation is that geographical diversification in international trade is an indispensable component of economic globalization, especially in the context of international risk-sharing, the benefits of which can be assessed through smoother macroeconomic fluctuations. The findings in this empirical work are based on a large amount of data analysis, along with the construction and introduction of various trade variables that capture international trade relations of an economy vis-à-vis its commercial partners and major players in the global economy. For the most part, the compiled panel data used in various parts of this research consist of 133 countries spanning sub-periods of different lengths, over 1960-2006. ❧ The first chapter addresses the impact that more geographically diversified international trade as well as trading partners with various economic characteristics have on business cycle volatility. We suspect simultaneity between volatility and our trade variables, and use an instrumental variable general method of moments estimation technique in most of our econometric analyses. We find that, for a given level of openness to trade among other country-specific characteristics, diversifying international trade among more trade partners with more evenly distributed trade shares among them–captured by a Herfindahl index for either imports or exports–is conducive to lower business cycle volatility. We use the standard deviation of the de-trended output time series, or the standard deviation of the growth rates of output as measures of business cycle volatility. We also find evidence that one of the likely stabilizing mechanisms of diversification is the mitigation of various types of domestic and international shocks. Further, we find that for the same set of controls, diversifying trade towards economies that are larger, more developed, and more stable is associated with lower business cycle volatility. To make this study even more similar to a portfolio view of international trade, we further demonstrate that after controlling for a measure of external shocks, having a less synchronized business cycle with those of the country’s trade partners is associated with smoother business cycles of major macroeconomic aggregates at home. ❧ In the second chapter, we examine various economic and geographic variables that we suspect to be associated with or influential to a country’s level of geographical diversification. Some of the findings in this chapter are as follows. More advanced economies and nations that reach beyond their bordering neighbors and establish trade with more distant countries tend to have more geographically diversified trade. However, countries with a large share of established trade with G-7 countries, or for which the official language is French or Spanish, or which are landlocked, seem to be limited in the extent of their geographical diversification. Finally, membership in the World Trade Organization or its predecessor has a positive impact on geographical diversification, but only within the first five years of that membership. Although we use gravity models as a guideline to construct multiple variables at a more aggregated level here, the implied levels of geographical diversification based on predicted values of bilateral trade flows from a Poisson pseudo-maximum likelihood estimation technique compare poorly with the actual computed levels. ❧ Chapter three explores the channels that challenge the widely-found empirical findings that trade openness has a destabilizing impact on various macroeconomic aggregates. In particular, using the same panel data and methodology applied in the first chapter, we document three main findings. First, a non-linearity in the output volatility-trade openness relationship is shown, and we estimate that beyond a certain threshold, de facto trade openness can turn into a stabilizing factor for output fluctuations. Second, we find that certain institutional and economic factors are capable of mitigating the destabilizing impact of exposure to international trade. Of these complementary variables, we examine financial openness, financial system development, and democracy. Finally, we find that international trade, when sufficiently diversified in geographical terms, is capable of becoming a stabilizing factor in relation to business cycle volatility of major macroeconomic aggregates such as output and consumption. More importantly, this type of highly diversified or global trade, enjoyed by the countries in the top 25 percentile of diversification, reduces the relative volatility of consumption to that of output, which is most frequently used as a measure of consumption-smoothing in the empirical macroeconomic literature and has been the most difficult to account for, especially by trade and finance variables.

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ESSAYS ON BUSINESS CYCLE VOLATILITY AND GLOBAL TRADE by Arian Farshbaf Yazdandoust
A Dissertation Presented to the FACULTY OF THE USC GRADUATE SCHOOL UNIVERSITY OF SOUTHERN CALIFORNIA In Partial Fulfillment of the Requirements for the Degree DOCTOR OF PHILOSOPHY (ECONOMICS)
August 2012
Copyright 2012 Arian Farshbaf Yazdandoust